What is Unrealized Loss and Profit?
A compact, educational article explaining what is unrealized loss or profit and when they can occur.
The goal of all hodlers, investors and traders is the exact same: to make profit and avoid loss. This may sound simple, but in reality it is often difficult and investors employ many different strategies or approaches to minimize risks and losses.
One of the more “hidden” dangers you can encounter when trading or investing is called unrealized loss (or profit). However, it isn’t all black and white — unrealized loss is a complex topic because it can act either as your friend by increasing the flexibility of an investment, or as your enemy, if you don’t pay attention to it.
But firstly, what is unrealized loss/profit…
Imagine a scenario: You invest 1000$ into a token, the token’s price rises and a month later, your investment is worth 1500$. Congratulations, that’s a 50% profit! However, until you actually sell your tokens into a stablecoin or fiat, what you have is unrealized profit. It is the theoretical profit you would get, if you sold. But until you do so, it’s only theoretical, in other words unrealized. After you sell your tokens, the investment/trade is 100% completed and your profit is realized, because it is no longer hanging on an exchange in the form of a volatile asset.
The same goes for unrealized loss. If your initial investment fell by 50% and your token’s worth was suddenly 500$, until you actually sell, the loss is “only” unrealized. This is why unrealized loss can act as your friend — yes, you are losing money on your investment, but until you sell, it is not definitive and the price can still swing back and at least mitigate the losses or even realize a profit in the end. Or alternatively, the price can drop even further, nothing is guaranteed. However, until you actually sell, the result isn’t firmly set either.
So, to summarize, unrealized loss is loss only “on paper” you haven’t actually lost anything yet. After you sell your assets, the unrealized loss becomes realized.
But, because unrealized loss/gain is only theoretical, it can be a subject to different types of accounting approaches, depending on what type of security you are holding. Securities that are held until maturity usually aren’t recorded in financial statement, but trading securities typically are. Moreover, when it comes to taxing an unrealized loss/profit, most capital gains are taxed only after they are realized, so fortunately no shenanigans here.